Friday, January 24, 2014

Robert Barro's famous polemic against New Keynesians

There has been some blog discussion lately (see Tyler Cowen and Scott Sumner) about Robert Barro, the famous Harvard economist who invented the controversial idea known as "Ricardian Equivalence", and who occasionally writes op-eds in the Wall Street Journal opposing fiscal stimulus. Cowen, Sumner, etc. are discussing whether Barro supports the idea of "aggregate demand" as a driver of business cycles. The paper most people know about is this one, but I thought it would be a good time to bring up Barro's epic polemic against New Keynesian models, from 1989. The title: "New Classicals and New Keynesians, or the Good Guys and the Bad Guys."

1989 was a time when the "macro wars" were much more intense than nowadays, and the "Freshwater/Saltwater" divide was much clearer. DSGE models were new, and two flavors of them had emerged: the RBC flavor, which assumed that the economy is driven by productivity ("technology") shocks, and the New Keynesian flavor, which assumed that "stickiness" in prices and wages is what moves the business cycle. The most prominent among the New Classicals were Edward Prescott, Robert Lucas, Charles Plosser, and Barro. The most prominent New Keynesians at that time were Greg Mankiw, Lawrence Ball, David Romer, Olivier Blanchard, and John Taylor. You can see that the divide wasn't a political one, since there were arch-conservatives on both sides.

In those days, blogs didn't exist, so when economists wanted to diss each other's ideas, they would write comments, short notes, or working papers (for another example, see Larry Summers' diss of RBC). Barro's polemic is actually a blog post in working-paper form. And like bloggers often do in the modern age, Barro makes it personal (and invents a taunting nickname). New Keynesians don't just have wrong ideas, he asserts, they are going about research totally backwards:

[T]he mission of the new Keynesian economics (which I like to describe by the acronym NUKE) is peculiar. Instead of providing new theoretical results and hypotheses for empirical testing, the objective often seems to be to provide respectability for the basic viewpoint and policy prescriptions that characterize the old Keynesian models.

In other words, Barro is accusing New Keynesians of reverse-engineering policy conclusions. He is saying that New Keynesians want to implement stabilization policies, and that their research consists of thinking of reasons why those policies might be warranted. This is an accusation that some bloggers still make against New Keynesian researchers - see here and here, for example - and that is still occasionally voiced behind closed doors by people who might reasonably be described as "Freshwater" macroeconomists.

In his polemic, Barro also makes a plug for the people he calls the "good guys": RBC theorists. Interestingly, he says this:

Overall, the real-business-cycle area has generated many new insights and techniques that assist in modeling the macroeconomy and in thinking about government policies. But it is not yet clear how much the models contribute toward understanding actual business cycles, or to the construction of policies that governments might wish to implement. [emphasis mine]

He says that the biggest contributions of the New Classicals has been their new modeling methodologies (which we now know as "microfounded Rational Expectations DSGE") and their interesting thought experiments:

[S]ome of the major successes of the new classical approach...include the application of equilibrium modeling to macroeconomic analysis, the use of rational expectations as part of this modeling, and the revolution in approaches to policy evaluation...

And he also takes the opportunity to plug his own work:

One specific application in which the equilibrium approach has achieved some success is in analyses of fiscal policy (see Barro, 1989b, for a survey). Some of this research revolves around the Ricardian equivalence theorem, which provides conditions under which substitutions of budget deficits for taxes are of no consequence. But further developments have brought out the real effects from government purchases and public services, the composition and timing of distorting taxes, and so on.

It's not clear what he means by "brought out"; he seems not to be talking about the relationship between theory and data, but about the intuitive appeal of his ideas themselves.

So what Barro is saying is that the New Classical/RBC people (himself included) were the "good guys" not because their models necessarily fit the facts better, but because A) their way of thinking about business cycles was more appealing, B) their motives for making their models were better, and C) they were personally responsible for more methodological advances than their New Keynesian counterparts.

This was a very interesting moment in the history of thought. An old paradigm, Old Keynesian models, had come into crisis, and a new paradigm, DSGE, was in the process of replacing it, but that new paradigm was split into two competing mini-paradigms, New Classical and New Keynesian (or "Freshwater and Saltwater", if you prefer), each jostling to carry the banner of DSGE.

Overall, the New Keynesians refrained from engaging in polemics like Barro's, and focused on the ways in which RBC models failed to fit the data (see the work of Jordi Gali here and here, and the work of Miles Kimball here and here). In 2006, Greg Mankiw came out with a blog-post-like working paper that was sort of a belated response to Barro, called the "The Macroeconomist as Scientist and Engineer," in which he expressed hope that the two competing sub-schools might learn to live in peace and divide up the kingdom of economics; Olivier Blanchard expressed a similar hope in 2008. The New Keynesians took the high road, and largely refrained from accusing the New Classicals of reverse-engineering a skeptical view of stabilization policy.

(But by the 2000s, the contest was largely over, and each side had gotten something that they wanted. The New Classicals had secured their place in history as the founders of modern macroeconomics, and everyone used their DSGE approach. But New Keynesians won the battle for the minds of policymakers; central banks often use DSGE models as part of their toolkit, and the models they use are New Keynesian models, not RBC models. But RBC survived too, spreading to other fields like asset pricing, international finance, and labor search, probably due to its ease of implementation compared to New Keynesian models. The happy synthesis hoped for by Olivier Blanchard didn't really exist, but the paradigm fight had settled down to a quiet, grumbling stalemate. Then the financial crisis came along and upset the whole apple cart, sending macroeconomists scurrying to find ways that the financial sector could be the cause of recessions.)

Anyway, I think it's interesting to see how this intellectual contest played out, because it's a window into how the field of economics works. Thomas Kuhn basically said that every field has its own standards for choosing between competing paradigms, and left it at that. Barro's polemic demonstrates how many macroeconomists are drawn to paradigms because of their aesthetic appeal, their methodological coolness, and (possibly) their policy implications. But the polite, data-driven, and ultimately successful fightback of the New Keynesians shows how other macroeconomists are more concerned with empirical validity. And the frequency of the paradigm crises in macroeconomics - one in the 1930s, another in the 1970s, and another in the 2010s - shows how few solid conclusions we can really draw from macroeconomic data (Note: On this point, see update below).

Why do I have to read this? The paper contributes nothing - not even an opinion or belief - on any of the substantive questions of macroeconomics...One can speculate about the purposes for which this paper was written - a box in the Economist? - but obviously it is not an attempt to engage other macroeconomic researchers in debate over research strategies.

See? Economists' discussions were not that different before the age of the blogs.

And apparently, according to people who were there, the conference where Lucas delivered the comment was even more contentious.

Paul Krugman thinks my skepticism is a little more extreme than it actually is. Of course there is tons of evidence that monetary policy has real effects. And that means that there is tons of evidence that models that assume such effects away - like the original, Nobel-winning Kydland-Prescott (1982) RBC model - aren't really going to describe the business cycle (I mean, Volcker...1980s...duh). And there is also evidence of nominal stickiness, although it's not yet clear exactly how the stickiness works. But that is not the same thing as New Keynesian models themselves being validated. There's often good enough macro data to tell what doesn't work, but usually not enough to tell what does work, which is a much taller order.

40 comments:

I don't think it's fair to say that the New Keynesians were any more data driven than the New Classicals. Part of the impetus of RBC was the inability of monetary movements to account for economic fluctuations in the VARs and Sims and others, and that the older New Classical monetary models of the 1970s couldn't pass other formal statistical tests. They then moved on to calibration in the 1980s. Now you may say that is a terrible way of confronting the data, but it is still dealing with the data in some sense. On the other hand, a lot of the seminal papers the New Keynesian movement are completely data-free.

Also, New Keynsians could write some polemics of a sort of their own: like Ball and Mankiw's "Sticky-Price Manifesto".http://www.nber.org/papers/w4677.pdf?new_window=1

This led to Lucas publishing the harshest comment ever (a Krugman quote seems to be partially what set him off):http://www.scribd.com/doc/77085319/Lucas

Ball and Mankiw's manifesto did not strike me as polemic at all, except for that one Krugman quote. Cool to see that Krugman's style hasn't changed!

Of course, RBC opponents did write polemics - Summers, for example, or Solow - but the people working to make sure that New Keynesian models triumphed over RBC seemed to generally stick to serious, empirically-driven work, while the RBC people mostly tended to dismiss their opponents.

@James - there are the Austrians and the Communists but they are more circle jerks than serious schools of economics.

@Noah - it seems to me that the difficult math of DSGE forces too many constraints on the models to be a useful approach. Big data should allow us to track neighborhood by neighborhood the effects on spending of government policy. Better computer modelling techniques would help too.

Thanks! Yeah, maybe it's not so much of a polemic as it is a tad dismissive and engaging in characaturing (unless you think they are right, of course). Framing subjects as "a choice" between believing something preposterous and whatever everyone else has always believed probably isn't the best way to promote healthy debate.

There is a great speech by Lars Hansen from an INET conference a few years ago that's on youtube (I can't post a link from my work, but it's not hard to find) that goes over the history of macroeconometrics after the original RBC models. Basically he says many of the original contentious parts of RBC from the early years were abandoned and it had modest ambitions to begin with. I think it's fair to say that both sides were heavily engaged with empirics.

As you say, eventually everyone got along a little bit better...at least on the surface. Part of this was that everyone got distracted by growth theory (both Delong and Krugman in Lucas's big paper on Growth!) and there was a synthesis. Lucas eventually even wrote a menu-cost paper and Mankiw switched the main friction to information problems like in the old Lucas models.

Wow, I really want a link to that speech! If you can find it, I'd love it.

Mankiw definitely became conciliatory in response to the RBC guys' attacks. And the harsh RBC critics, like Summers, basically started ignoring macro. that's why I wrote that the New Keynesian fightback was mainly polite and empirical in nature.

I'm interested in how and when and why those parts of RBC got abandoned. I'd love to hear more of the story! My email is nquixote@gmail.com if you don't want to reveal your identity in public...

Chris Sims and Harald Uhlig also give interesting speeches at that event. Chris Sims - a frequent critic of many of the popular models, but I guess also an impulsive contrarian - offers a defense of DSGE models. Harald Uhlig shows some data that challenges some basic assumptions in various models.

Sadly, I have no special insight from first hand experience...but I'm flattered that I could fool you! Just some guy who got addicted to the blogosphere a few years ago after getting my bachelors and then started reading the actual journal articles obsessively. One day I may apply to grad school; I recently read an article by two highly respected scholars that recommended it!

" The Moody's model that Christina Romer -- here's what I think happened. It's her first day on the job and somebody says, you've got to come up with a solution to this -- in defense of this fiscal stimulus, which no one told her what it was going to be, and have it by Monday morning. So she scrambled and came up with these multipliers and now they're kind of -- I don't know. So I don't think anyone really believes. These models have never been discussed or debated in a way that that say -- Ellen McGrattan was talking about the way economists use models this morning. These are kind of schlock economics. Maybe there is some multiplier out there that we could measure well but that's not what that paper does. I think it's a very naked rationalization for policies that were already, you know, decided on for other reasons..."

And yet if you go to the famous Summers memo about stimulus recommendations to President-elect Obama:

You'll find on pages 10-11 a number of people who advocate stimulus like Goldman Sachs, Senior Federal Reserve officials, Rogoff, Zandi, Feldstein, but not Makiw who is skeptical. Summers mentions an open letter by 387 economists calling for stimulus including Nobel winners Solow, Akerloff and Stiglitz.

With respect to your update. I wasn't there, but I have seen Lucas deliver a very harsh critique of a paper presented by Steve Williamson on New Monetarism. He basically said that there was "nothing new" in it (blah, blah, blah). But afterward, I saw Williamson and Lucas chatting with each other, laughing.

I think you may have experienced something like this yourself. Lucas comes at you hard, but you get the feeling that he is equally hard with himself. And heck, it's all just meant to provoke an honest discussion.

I'm sure that Krugman is a wonderful human being. Regarding Lucas, I think he can be a meanie. I saw him smack Williamson around pretty good. I saw him smack you down pretty darn good too. So yes, he can come across as dismissive. The question is: what comes after? Is he willing to talk? Is he willing to listen? Does he keep an open mind? Or is he instead blinded by religion? Why don't you tell us what happened when you went up to speak with him personally after he dismissed your comment at the St Louis Fed Q&A event?

Hmm. As I recall, I initially asked Bullard if the Fed's carefully cultivated anti-inflation attitude might be hurting efforts to get Americans to believe that 2% is really a target instead of a ceiling, and if maybe it might help shift expectations if the Fed Chair were to openly muse about 4% inflation not being so bad.

Then Lucas broke in and said "We tried @#$!&$# inflation in the 70s, and it didn't work!"

Then I went over to him afterward and explained what I had really meant - not that there was a Phillips Curve, but that the Fed might accidentally be seeming too scared of inflation to even hit a 2% target - and he basically just said "I see what you mean, but no. Price stability is the most important thing." And that's all we had time for before a bunch of people came over and started talking to him.

lol. Are these "feelings" like good vibrations & can anyone else tune to the frequency ?I get the feeling that some people suffer from an acute Rodney Dangerfield complex when it comes to Krugman. He was not even in the conversation.

"There's often good enough macro data to tell what doesn't work, but usually not enough to tell what does work, which is a much taller order."

Well, yeah... you must've heard about the idea of "falsification", right? And the reason Popper and followers tried to elevate it to the central role in the scientific method is because positive knowledge is so difficult to attain.

In practice, a theory that manages to explain and predict and that survives for some time without disproof will get regarded as true, at least provisionally... provided it's capable of disproof.

Noah: "In other words, Barro is accusing New Keynesians of reverse-engineering policy conclusions."

It is not only Barro and freshwater economists that accuse New Keynesians of this. I vividly recall a post by Nick Rowe: http://worthwhile.typepad.com/worthwhile_canadian_initi/2013/11/optimal-fiscalmonetary-policy-in-hybrid-oldnew-keynesian-models.html

The main point is that if one examinest New Keynesian model by itself there are more policy conclusions, to be made. For instance

Nick here points out that it is only if you approach New Keynesian models with Old Keynesian intuition that you get results that you want. But this is then mixing two theories.

Thomas Humphrey wrote an excellent 250 year long literature survey of the rules versus discretion debate in the 1998 Richmond Fed Quarterly.

He wanted to know if macroeconomics was a progressive science in the sense that superior new ideas relentlessly supplanted inferior old ones.

Humphrey found that:• Keynesian ideas about a lack of demand and their many antecedents gain currency when unemployment was the main concern.• Monetarist ideas tended to reign when price stability was the main problem.

The policy debate keeps recycling because 1. people forget the lessons of the past and2. For better or worse, politicians and the public have tended to believe that central banks, the focus of his studies, have the power to boost output, employment, and growth permanently.

Humphrey showed that stable policy rules are popular in good times to contain inflation, and when unemployment was rising, discretionary monetary policies returned to policy vogue.

Humphrey concluded that doctrinal historian knows that much of what passes for novelty and originality in monetary theory and policy is ancient teachings dressed up in modern guises.